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Economic Freedom, Wealth, and the Alleviation of Poverty

By Salil Dudani on February 19, 2013

The government should do less, not more, to improve the economic welfare of the nation and the nation’s poor, according to Stanford economics professor John Taylor. This was the thrust of Taylor’s argument in a recent Ethics of Wealth lecture called “Economic Freedom, Wealth, and the Alleviation of Poverty.”

Taylor began his talk by outlining the present problems with our economy: high unemployment, low-income growth, high poverty, high-income inequality, and low intergenerational mobility. Our recovery from recession has been exceptionally slow. The average growth rate following the eight previous recessions was about 6 percent, but since our recovery began in 2009 our average growth rate has been around 2 percent.

Why? One common response is that recovery is slow because recession was deep. American history, however, reveals the opposite trend: The deeper the recession, the higher the growth rate during the recovery. Another theory is that recovery has been slow because too many people are saving rather than consuming.

But, according to Taylor, history speaks against this interpretation as well: people are saving much less as a fraction of income than they were after other recessions. Taylor also rejected the argument that the housing sector explains the comparatively slow rate of recovery.

So what’s left? The government’s economic policies, according to Taylor. “My theory is best described as: We’ve gotten off track in following basic economic principles…This makes most sense to me since I’ve been teaching economic principles for so many years.”

“My theory is best described as: We’ve gotten off track in following basic economic principles…This makes most sense to me since I’ve been teaching economic principles for so many years.”

Taylor’s “principles of economic freedom,” which he described as characteristics of good economic policies, include a few key ideas. First, people are free to make decisions about buying and selling within a predictable policy framework, in the sense that they understand what the government is going to do. Second, there are strong incentives flowing from a market system. And, third, there is a clearly defined and limited role of government, determined by cost-benefit analysis comparing the government to the private sector on a case-by-case basis.

“Unfortunately, we sway back and forth from greater and lesser adherence to these principles. Let’s call that the shifting winds of economic freedom,” Taylor said. He then gave a historical sketch underlying the argument that our economy has been better off when the government has abided by the conservative economic principles he favors.

In the 1960s and 1970s, Keynesianism—the view that the government should stimulate the economy to overcome downturns in the business cycle—became fashionable in Washington. There was much intervention in the economy from the Federal Reserve, there were bouts of short-term fiscal stimulus, and there were price controls under Nixon. And the results were “terrible,” as evidenced by the high unemployment and inflation rates of the period.

Starting in the late 1970s and stretching through the 1980s and 1990s, however, the winds shifted back. Under Paul Volcker, the Fed assumed changed direction. Policies became more predictable, and regulations were scaled back. Taylor sees an “amazing correspondence” between these changes and economic success, and economists call this period “the great moderation.”

But Taylor believes we’re swaying back in the wrong direction. According to Taylor, in 2003-2005, loose monetary policy contributed to a housing boom which ended in a bust, and in 2008 the government passed the first big stimulus package since the 1970s. “What has been associated with this? Terrible performance. A serious crisis, a serious but slow recovery…It’s just a correlation, but when I look at the details, this is the conclusion I come to,” Taylor explained.

Hammering in his point, Taylor then provided a graph of unemployment since the 1940s, noting the correlation with his historical sketch. “Again, it’s not proof, but it must make you think that there’s something going on here with respect to economic policy and its effect on people’s lives.”

Income distribution and wealth inequality

Taylor then pivoted to address an issue past speakers in the Ethics and Wealth series have also addressed: inequality. “Having said all this, some of you might be saying, ‘Isn’t Taylor missing a big part of the story?’” Taylor said. That part of the story, he went on, is income distribution, which was a concern during the Great Moderation and has only worsened since then. The income share of the top one percent began a “pronounced” increase in the 1970s. In 2012, the top 10 percent have 50 percent of the income.

Parsing the data on income distribution, Taylor is concerned that equality of opportunity is declining in America. “I’ve actually taught in my classes that we’ve had a considerable amount of (personal) mobility over time. But the data is beginning to question that…Unfortunately, looking at intergenerational mobility, the likelihood of someone being well-off (when their parents were not) seems to be decreasing.”

The role of education

Taylor concluded his talk by pointing to education as a factor that might help explain the recent worsening of economic inequality in America. He noted that in the mid-1980s, three trends began at once. First, the income of the top 10 percent began growing much faster than that of the other 90 percent. Second, returns to education began increasing: it became more profitable than ever before to go to college and obtain advanced degrees. Third, and surprisingly, the number of high school graduates began to decrease.

Combining these three trends, the resulting picture is one in which gaps in education might contribute to gaps in wealth. When fewer students pursued degrees at a time when those who did experienced large payoffs, upper income brackets grew in relative prosperity. Taylor argued that education is “an economic freedom issue”: If students attending poor schools are not given the freedom to change schools, their economic freedom is threatened as a result, violating Taylor’s core economic principles.




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